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07/02/2006

Buffett and Giving-BECKER

Very wealthy men and women like Warren Buffett and Bill Gates would frequently create charitable foundations even if that did not help them avoid estate taxes on their wealth. After all, the estate tax was negligible when Rockefeller and Carnegie created their large foundations. Nevertheless, a sizable estate tax that exempts charitable giving has encouraged the creation of many large private charitable foundations in the United States.
Private giving to various causes is a substitute for public giving, and private giving tends to be more effective because of the competition among different foundations and other charities. In this respect I believe the US market for giving is much better than the European approach because financing of the arts, higher education, hospitals, and many other activities to a considerable extent comes from governments in Europe, while in the US these activities much more depend on fees for services and private donations. Competition among private donors is as conducive to efficiency and productivity growth in these fields as is competition among producers of cars and other such goods.
Although this will not be the main focus of my discussion, I support the abolition of the estate tax, or at least its significant weakening to cover only very large fortunes, perhaps along the lines of the recent bill on reform of the estate tax passed by the House of Representatives. The present estate tax is too discouraging to accumulations of moderate amounts of capital in small businesses and other ways. It also encourages legal and accounting spending devoted solely to finding and exploiting loopholes that is considerable relative to the tax revenue the estate tax raises (about $30 billion in 2005). If the concern is about inequality caused by inheritance, the tax should not be on estates, which may be divided up among a number of heirs, but on the amounts inherited by individuals.
Decentralized private charitable giving can be encouraged through the tax system even without an estate tax, as long as charitable contributions can be generously deducted from income taxes. Indeed, as I argue below there are advantages from having foundations created while donors are alive rather than mainly after their death. However, if the estate tax were abolished or substantially weakened, it would be desirable to raise significantly the cap on giving in the federal tax code-set presently at 30% of adjusted gross income- to a much higher per cent, perhaps 100 % or even higher (if higher than 100%, there might be a loss carry over provision).
This brings me to my main topic, Warren Buffett's announced gift of over $30 billion to the Bill and Melinda Gates Foundation. It is unusual in that this amount and any interest earned are supposed to be entirely spent by the time the Gates' have either died or no longer run their foundation. Even more rare for such a large gift is that Buffett is not creating a foundation with his name, but instead is giving the money to a foundation created and soon to be managed by his friend, Bill Gates.
Most foundations continue long after the death of their creators, and after replacement of the initial managers and Boards. This commonly leads to a shift away from the donors' intent. Partly that is desirable given unanticipated changes in the social and economic environments, and in the resources supplied by other donors and by governments. Most people recognize the need for foundations to react to these fundamental forces, but another type of change over time in foundation goals is more disturbing. Self-made businessmen who usually have strong beliefs in capitalism and a competitive market system create many of the large foundations. Such "conservative" views often guide the early days of their foundations' activities, partly because the donors choose managers and Boards who are sympathetic to their beliefs.
Over time, however, foundations frequently become more liberal, as management and Boards change. Although the market for foundation executives is highly competitive, these executives typically come from education and family backgrounds that are similar to those of modern journalists. As a result, foundation executives also tend to have a "liberal" outlook on the role of government, and the most pressing social and economic questions. This liberal outlook often clashes with the views of the original creators of the foundations they manage.
Examples of the shift from conservative to liberal over time include the large Ford and Pew Foundations. Some foundations created after the death of a conservative donor, such as the MacArthur and Packard Foundations, from the start have a much more liberal orientation than the donors. I do not know of any prominent examples that moved the other way, from initially liberal to becoming conservative over time. A solution to the problem of the shift over time away from the intent of donors is for donors to require that their foundations give away all their assets by a set date, or shortly after their deaths or that of managers they trust. The Olin foundation is the most prominent large foundation that was directed to, and did, succeed in giving away its assets by a set date. It accomplished that goal, under the leadership of William Simon and James Pierson, while giving its money in a thoughtful manner, such as funding a number of prominent Law and Economics programs at Law Schools.
Warren Buffett believes in capitalism and competitive markets, but he is not a "conservative". Still, he is concerned that over time his huge gift would be used in ways that he would not approve. So he is following the example set by Olin and a few other foundations, and he is installing a sunset provision that would require all his charitable assets to be spent by the time the Gates" have either died, or withdrawn from an active role in their foundation.
Even more unusual is his decision not to set up a new foundation under his name, but to give the bulk of his fortune to the Bill and Melinda Gates Foundation. He has chosen to place his philanthropic money in the same manner as he invests the money in his funds; namely, by picking managers that he believes will use the money well and yield a high return. The only difference between spending charitable and investment monies is that the former yields returns in the form not of profits, but in terms of effectiveness in furthering the donor's aims. The Gates foundation has so far been spending most of its money on promoting health in developing countries through attacking diseases that are more common in these countries, such as malaria. From the little I know about this foundation, it has spent its money relatively well. So it does not seem surprising that Buffett has confidence in this particular foundation.
What Buffett is doing may be wise, but is very uncommon because most large donors want their names on the Foundation they create, and also on the organizations sometimes set up by recipients of their gifts. Even the Olin Foundation generally called the Law and Economics Centers they created after Olin. That Buffett could resist the temptation to have a foundation monument in his name testifies not only to his wisdom but also to the inner confidence of the man.

Comments

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I consider myself a conservative (or classical liberal). But I don't understand Professor Becker's argument against the estate tax. If there was an estate (death) tax of 75% it would certainly be unfair, it would punish the proginy of the hardworker, but would it really discourage hardwork and economic success. The incentive for success seems to me to be rooted much more in the here and now.

I'm just thinking about this from a personal perspective. I have two daughters. I work hard and create a business, a product, a service, I manage and grow the business. When I die, my daughters get 25% of the capital that I accumulated, rather than 75% or 100% -- what is my alternative? Out of spite towards taxation, I punish my family even further by not working, not creating and not being successful. That doesn't seem rational.

I might just be bitter and bias, as I've known some truly iritating trustifundians.

The estate tax is the most unfair of all taxes. It tells individuals who have been paying the most taxes at the highest rates that when they die, the government will take half their money again. I don't see why dying wishes shouldn't be honored.

Furthermore, it makes a lot of people who have worked hard all their lives have to spend their dotage figuring out how to get rid of their excess, rather than being able to retire and relax.

It also punishes people who are succesful financially but have to misfortune of dying young before they can figure out what to do with their money.

Finally, it doesn't raise that much money and is a massive form of social engineering/government intervention into our private lives.

I was deeply touched by Warren Buffets gift, because the combination of competence and selflessness with which it was given was another testament to the potential for good that resides in human beings.

Warren Buffet also shares his opinion on inheritance. He calls those who are left big fortunes "members of the lucky-sperm club". DosPeros (above) is wrong, however, in suggesting that estate tax does not reduce the incentive to work hard to build a fortune. Assuming that each individual is facing a trade-off between creating a large estate and other goods (eg. leisure or time with the family), then that trade-off is tipped in the direction of the other goods as estate tax increases.

I have long thought the best solution to the estate issue is the following and wonder what you think of it.
For moral reasons (you should be able to do what you want with what you earned) other than paying the usual capital gains taxes at death, you may pass on your estate free of any additional taxes. At the death of your beneficiaries however, they may pass on only the excess they made over some benchmark (say the growth of the US Economy over the time period). This would for example mean that all fortunes such as the Rockefeller's would have vanished after one generation and wealth dynasties such as theirs would become essentially impossible. Obviously there are technical issues involved that may be insoluble but as a "modest proposal" this seem to cut through the knot.

(1) It is a steeply progressive policy (in fact, I'm not aware of any other tax policy which is more progressive), affecting only the richest of the rich in the US (300,000 at last count). The aims of a redistributive tax/transfer system seem well served by collecting tax here.

(2) In the US it is applied only on the "taxable estate" (less than the entire estate); there are significant deductions/exemptions available (which peak at an exemption up to an estate worth $3.5m in 2009 - but the status after this is unclear)

The current exemption stands at $1.5m - that is to say; it will not apply until it reaches this level. Even if it does, the current marginal tax rate (of every additional dollar of taxable estate value over $1.5m) is 50% (falling to 45% from 2007-2009).

I accept that it does distort incentives (as any redistributive policy is want to do). However, the inefficiencies created seem minor to those that would be created elsewhere (e.g. if the same taxation revenue were to be made up from increased income taxes).

Nonetheless, I am strongly in favour of such a tax. It has been recognised (especially amongst the richer people themselves - e.g. Warren Buffet) that the highgly progressive nature of this tax is beneficial.

It does not tax those who can least afford to pay (as many regressive taxes do), but targets the richest of the rich. Furthermore, the substantial exemptions and deductions available, and the marginal tax rate (45% of the taxable estate, as of 2007) leave substantial assets to be inherited (contrary to the claims of those who support the abolition of the tax; this tax does not 'strip' rich people of their assests).

The incentives of the estate tax have been brought up, but no one has addressed the effects of large inheritances on incentives. While a high estate tax does lower incentives to be productive and/or amass great wealth [the two aren't congruent], doesn't a lack of estate taxes lower incentives to work in the next generation? That is, if Warren Buffet had left his entire fortune to his children and they had inherited it all tax-free, what incentive would they have to work at all? While I understand that in practice [not necessarily in theory] the very wealthy are necessary because their savings are used for investment, I feel that a large fortune destroys the incentives to work for the next few generations. This is especially damaging because the children of the very rich usually go to the best schools, receive the best health care and nutrition, and generally have the best potential to be productive members of society. While keeping them out does open the door for others, I am sure no one is advocating that productive members of society not work so that others have a chance, just like no one would want the best athletes in a sport to sit out so that more people get to be major leaguers.

Billionaries should simply start new universities instead of or besides giving money to a foundation. A really smart play on keeping foundations conservative would be to provide a seperate line of funding for incremental compensation for top officers of the foundation. True conservatives in the non-profit sector still care about their take home pay (more than others in the non-profit sector).

As to whether Warren Buffett's wishes concerning his gift will be honored posthumously, I doubt it. Someone always has a better idea than the next person (or the deceased) about how money should be used. Were that not so, economists by and large would have little to do.

Abolishing the estate tax is not so important as lowering the confiscatory rates at which it is imposed. The estate tax is easily avoided by (A) paying attention to a smart financial advisor early in one's life path toward wealth accumulation, (B) spending it all before you go, or (C) giving it all to charity.

None of the three choices above is a "bad" decision our tax code should dissuade.

The estate tax is a huge straw man for the simple reason that we have a full capital gains basis step-up at death.

Warren Buffet for example is reputed to have never sold a share of Berkshire Hathaway. We can assume however, that he has amassed massive capital gains on the initial value of his stock. Removing the estate tax simply strengthens the lock-in effect and distorts all incentives to trade the stock when nearing old age.

Talking about the estate tax w/o mentioning the treatment of capital gains at death vs. other occasions is silly.

What is the evidence that there is substantial competition among foundations? Competition exists among businesses because the purpose of a business is to make money, and my competitors' income often comes at the expense of mine. There's no analogy with foundations. While charitable foundations must pay attention to their revenue, a foundation that acts as a donation-maximizing institution is betraying its donors and its institutional role.

There is surely at least some competition between foundations, but I am unconvinced that it is a substantial driving force of foundation action, or should be.

I serve on the boards of two foundations, and I agree with Elliot's post.

Also, Richard Mason is mistaken in his notion that the Catholic Church was initially liberal but is now conservative. From its inception the Church always taught what we would today regard as "conservative family values" in social matters, and never really espoused an economic philosophy at all since She never confused economic systems with a way of life. She always advocated charity, but the specific role of government in these matters is not a part of the Magisterium.

"That Buffett could resist the temptation to have a foundation monument in his name testifies not only to his wisdom but also to the inner confidence of the man."

Confidence? I can't help but wonder whether a dozen different terms might be more fitting. Selflessness, perhaps?

Selflessness, however, is less attractive from a micro-economics perspective. Is it rational to be selfless? What are rational acts to pursue as one nears death?

I love free markets and capitalism as much as the next man, but it is important to consider where its theoretical and real boundaries end. People don't always act rationally and in many cases, we ought to celebrate this! Buffet and Gates are spectacular examples of people who have achieved their self-interested goals in life, and have progressed on to a higher plane of contribution - humanity triumphing over rational self-interest.

I am surprised by the fact that Buffett seems to be drawing negative feedback from some in the press. In the website Comment is Free, run by the UK's Guardian newspaper, there is a piece by Gavyn Davies, former Goldman Sachs partner and head of the BBC. Davies says: "So Gates will probably become the all-time champion giver before he dies. But whether this will get him to heaven is another matter entirely. The Gates foundation currently employs fewer than 300 people to decide how to give away the $3bn a year that a foundation of $60bn will create. Can they get a good return on this money, in terms of lives transformed for the better? And can they do this better than governments, who could tax these massive bequests and then spend the proceeds? We shall see"

Well given the wastage that is legendary in Government spending, I doubt the last comment very much. And although Davies has recently been on the public payroll, it isn't where he's spent most of his career and I would be amazed if he suddenly announced that he finds the government departments in which he's now involved to be more efficient than the likes of Goldman Sachs.

And what is with the comment about the number of employees at the Gates foundation? There aren't that many more at Goldman Sachs relative to the amount of billions they make decisions on day to day; in fact, I'd wager there are less.

I think it is less that charitable organizations drift liberal over time, but that the act of giving is liberal leaning and giving draws this out. Conservatives don't give that much over their lifetime because they are conservative and believe people should fend for themselves.

While the estate tax is nominally a wealth tax, it is best considered an income tax, income on which no tax was ever paid on or it would never have amounted to that much, and for which the recepient has done nothing but chosen the correct parents. As motivating as demotivating. If you want to leave a particular size inheritance, you would just have to accumulate that much more. Leaving children to live lives of indolence and squander is about as immoral as it gets.

Buffett deserves the praise he is getting for his philanthropy, but his decsion to let Bill Gates control his money rather than the government seems to indicate a lack of confidence in the government's ability to allocate resources. But if he considers the government a poor allocator, why does he want the rest of us to give our estates to the U. S. Treasury?

He shows great wisdom in keeping his estate away from the government. I wish he would let the rest of us do the same.

Everyone seems to be talking about Buffet's and Gate's billions and what "really" should be done with them. Do I detect a green eyed demon in all of this? As for myself, I'm just hoping and praying that my pension will still be there when it comes to retire. As for understanding Buffet's actions you really need to be a graduate of Rose Hill school. ;)

I personally support the estate tax. I think a moderated estate tax is useful. I think all estates should be taxed at a flat rate. I think it would be fair to tax the transfer as a capital gains to the recipient.

I think progressive tax structure create poor incentives.

We cannot control our parents, and it seems unfair to me to tax the income on the living but not the transfers of the deceased.

An estate tax is useful to raise funds. There are many tax planning techniques that will preserve an estate.

The law and economics issues are very legitimate. But I feel that income taxes are too high, and any means towards income tax relief for the middle class is highly desirable.